Fed Leaves Hedge Fund Bears Waiting on Emerging-Markets Bet

Ben S. Bernanke, chairman of the U.S. Federal Reserve, speaks during a news conference following the Federal Open Market Committee meeting in Washington, D.C. on Sept. 18, 2013. Photographer: Pete Marovich/Bloomberg

Sept. 19 (Bloomberg) -- Ray Bakhramov has been waiting
almost two years for his hedge fund’s bet against emerging
markets to pay off, which spurred a 20 percent loss in 2012 and
cost him clients. Even with a slump from bonds to currencies
over the last five months, he’s still waiting.

Bakhramov, whose $180 million Forum Global Opportunities
Fund posted gains this year after shorting South Korean and
Turkish government debt and wagering against mining and steel
companies reliant on developing economies, remains in the red on
his bearish outlook. He says his best returns will come once
central banks unwind their record stimulus, something the U.S.
Federal Reserve unexpectedly refrained from doing yesterday.

“What we’ve seen so far is just a preview,” Bakhramov,
45, said in a telephone interview from New York this week. “A
slowdown in any asset class is not a two-month or even a one-quarter phenomenon. When you go through a major repricing, the
process of bottoming out typically takes about four years.”

Fed Chairman Ben S. Bernanke triggered the emerging-markets
slump when he signaled May 22 that the Fed may curtail its bond
buying, luring capital away from nations that offered higher
yields and relatively low risk as long as central banks were
backing the global economy. More than $47 billion has been
pulled from global funds investing in emerging-market stocks and
bonds since May, according to EPFR Global, a Cambridge,
Massachusetts-based data provider.

‘Bit Disappointing’

Hedge funds haven’t reaped the benefits of the emerging-market selloff because the currencies that fell the most this
year aren’t easily bet against, some managers put on the wrong
trades and volatility made it hard to stay in positions,
investors said. What’s more, the worst of the emerging-market
selloff may have already passed, analysts at Barclays Plc and
JPMorgan Chase & Co. predict.

“Performance has been a bit disappointing,” said Anthony
Lawler, who oversees $6 billion invested in hedge funds at GAM
in London. “Hedge-fund managers have been looking for something
to break, and central banks have been trying very hard to not
let anything break.”

Brevan Howard

Hedge funds focused on emerging markets, the investors who
charge the highest fees to navigate developing economies,
account for $155 billion of the industry’s $2.4 trillion of
assets under management, according to Chicago-based Hedge Fund
Research Inc. The funds slumped 0.8 percent on average through
the first eight months of the year, with performance dragged
down by money managers who lost money after failing to
anticipate the slide for stocks, bonds and currencies, that
Bernanke prompted four months ago.

The $2.7 billion emerging-markets fund at Brevan Howard
Asset Management LLP, Europe’s second-largest hedge-fund firm,
declined 12.7 percent this year through Sept. 13, and New York-based QFR Capital Management LP, a $3.5 billion firm that
invests in developing nations based on macroeconomic trends,
lost 13.4 percent in its fund through August, investors said.

Firebird Management LLC, a New York-based firm that
oversees $1.1 billion in emerging-market equities and private-equity investments, restricted clients from pulling money from
one of its funds in July due to “significant redemption
requests coupled with the illiquid nature” of the holdings,
according to a notice on the Bermuda Stock Exchange’s website.

A spokesman for London-based Brevan Howard declined to
comment on the fund’s performance. Officials at QFR and Firebird
didn’t return phone calls and emails seeking comment.

Fed’s Strategy

While booming economies such as in China, Brazil and India
have been fueled by consumer demand, the bearish case against
emerging markets is based on the view that global capital flows
have primarily sparked asset gains. The combination of slower
growth and the Fed curtailing its monthly bond purchases will
accelerate the pace of redemptions, triggering a slump for
stocks, debt and currencies, Bakhramov and other hedge-fund
managers predict.

The Fed said yesterday that it wants to see more evidence
that the U.S. economy is improving before reducing its bond
buying. Economists had forecast the central bank would dial down
U.S. Treasury purchases by $5 billion to $40 billion, while
maintaining its buying of mortgage-backed securities at $40
billion, according to a Bloomberg News survey.

Markets Rally

The MSCI Emerging Markets Index jumped 2.3 percent as of
9:34 a.m. today in London, the biggest gain in more than two
months. A group of the 20 most-traded emerging-market currencies
rose to the highest level since June, and JPMorgan’s index for
dollar-denominated bonds in developing nations posted the
largest rally in almost three months.

Before the Fed’s announcement emerging-market currencies
were headed for their biggest annual decline against the U.S.
dollar since 2008. Still, those that fell the most after
Bernanke first hinted at tapering, the Indian rupee and the
Indonesian rupiah, haven’t led to windfalls for hedge funds,
said GAM’s Lawler.

The rupee and rupiah aren’t liquid enough to bet against in
a meaningful way, leaving hedge funds to focus bearish wagers on
currencies such as the South Korean won, which should fall if
economic growth in China slows, Lawler said. The won trade
hasn’t worked this year, as it’s gained 4 percent since May 22.

Brazilian Real

A trade that some hedge funds missed is the Brazilian
real’s slide, Lawler said. Instead of betting on the currency,
money managers wagered that slowing growth would lead Brazil to
cut interest rates, he said.

Stephen Jen, the former global head of currency research at
Morgan Stanley who now runs London-based SLJ Macro Partners LLP,
was one of the earliest and most vocal hedge-fund managers
predicting an emerging-markets slump. He said during a February
2011 conference at the London School of Economics that emerging-market stocks and bonds would underperform. He’s since been
quoted in articles by Bloomberg News, the Economist and other
publications warning that slowing growth and the reversal of
capital flows will crush currencies.

‘Significant Weakness’

Jen, whose firm also helps institutions and corporations
hedge their risk to currency moves, remains convinced that the
worst is yet to come. In a note to investors this month, he said
the International Monetary Fund estimates that investors pumped
$7.7 trillion into emerging markets over the past decade. Data
indicate that just 10 percent of that has been pulled, and the
Fed hasn’t even started tapering, Jen said.

“We remain firmly in the camp looking for further
significant weakness,” he wrote in the Sept. 4 letter obtained
by Bloomberg News. “Sell-side analysts have been too bullish on
emerging markets based on the demographic trends, oblivious to
the emerging-twin deficits, the overextended credit cycles and
extreme valuation of both the currencies and the underlying
assets.”

Jen’s SLJ Macro Fund, which trades developed market and
emerging-market currencies based on global macroeconomic trends,
rose 13.3 percent in the first eight months of this year and is
up 15.7 percent since it started trading in November 2011, the
letter shows. Unlike most hedge funds, SLJ reports its
performance excluding fees. The fund charges management fees
ranging from 1.5 percent to 2 percent to oversee clients’ money
and pockets either 15 percent or 20 percent of any investment
gains it makes on trades, according to the investor note.

Jen, 47, declined to comment on his investment performance
or how much money he manages at SLJ.

Bakhramov’s Performance

Russian-born Bakhramov, who previously structured asset-backed securities at Credit Suisse Group AG, outperformed peers
during Forum’s first six years of trading. He never posted an
annual loss, a run that included an average annual gain of about
42 percent from the start of 2007 through the end of 2010, said
investors, who asked not to be identified because the returns
aren’t public. The hedge-fund industry had an average annual
gain of 4.2 percent over the same four years, HFRI data show.

Difficult 2012

Then came 2012. Bakhramov positioned his portfolio for an
emerging-markets slump and lost 20 percent. The hedge-fund
industry rose 6.4 percent last year. Bakhramov told investors in
his New York-based Forum Asset Management LLC that he watched in
disbelief as central banks continued to pump endless amounts of
money into the global economy.

With the Fed now laying the groundwork for pulling back, he
said his time has come. The jump in interest rates prompted by
Bernanke just talking about tapering shows that preventing a
further rout in emerging markets may be beyond central banks’
control, especially if developing nations and companies start
struggling to fund themselves, Bakhramov said.

Among the trades he’s put on is a bet against the Chinese
yuan and buying credit-default swaps on ArcelorMittal and
Glencore Xstrata Plc, derivatives that pay out if the
creditworthiness of the companies weakens, clients said. While
the Forum fund was up about 6 percent this year through August,
it lost money this month when emerging-markets rallied after
China reported export and production figures that exceeded
economists’ estimates.

Ali Akay

The September rally shows “people are still complacent
that the Fed will take care of every problem,” Bakhramov said.
“The mistake that people are making now is that they have
accepted that emerging markets are an issue, but they don’t
think it will be a big issue. We have our doubts.”

A hedge-fund manager who has successfully picked which
emerging-market stocks will rise and fall this year is Ali Akay,
a former SAC Capital Management LLC trader whose London-based
Carrhae Capital LLP has gained about 9 percent through August,
investors said. His $480 million hedge fund made money in July
shorting potash companies that plunged after OAO Uralkali, the
world’s largest producer of the soil nutrient, abandoned
production limits that underpinned prices, a note to Carrhae’s
investors shows.

Akay, 36, and Rob Kirkwood, Carrhae’s head of business
development, didn’t respond to requests for comment.

In a short sale, traders bet stock prices will fall by
borrowing shares from a broker and selling them. They plan to
buy back the stock at a lower price, return the shares to their
broker and pocket the difference as profit.

No Clarity

Investors should probably avoid hedge-fund managers wedded
to either bullish or bearish views on emerging markets until
there’s more clarity about the effects of the Fed curtailing its
stimulus and the turmoil in the Middle East over Syria, said
Alper Ince, who helps oversee $9 billion at Pacific Alternative
Asset Management Co. in Irvine, California.

“You want someone who can trade these markets nimbly,
going both long and short,” said Ince, whose firm invests in
hedge funds on behalf of clients. “Emerging-markets
underperformance looks overdone to me since May, but I’m not in
the position to say now is the time to load up on exposure
because there is so much uncertainty.”